Taxpayers can ease the pain of preparing tax returns simply by knowing the Internal Revenue Service's (IRS) definitions of certain significant terms that have major impacts on taxable income. Some of the most important accounting terms for taxpayers to know include gross income, adjusted gross income and modified adjusted gross income (MAGI).

Gross Income

An individual’s gross income is simply his or her total earnings, not otherwise exempt from taxation, throughout any given year. Wages, salaries, commissions and net business income are included in the gross income tally, and this number is used to determine whether an individual needs to file a return or if a person can claim an individual as a dependent. If gross income is less than a certain amount, filing a tax return may not be necessary.

Adjusted Gross Income

An important accounting figure helpful in determining an individual’s total taxable income in a given year is adjusted gross income. This figure is determined by subtracting adjustments, or above-the-line deductions, from an individual’s gross income. Adjustments can include traditional IRA contributions eligible for deduction; qualified retirement plan contributions; payment of alimony; and interest paid on student loan balances. For the self-employed, health insurance premiums and one-half of self-employment taxes paid throughout the year also affect adjusted gross income.

The adjusted gross income calculation is important to an individual’s tax return as it is used to determine a person's eligibility to take additional deductions to further reduce taxable income. Both state and federal tax preparations require the calculation for adjusted gross income to be completed properly to determine further deduction eligibility.

Modified Adjusted Gross Income

Where most taxpayers get confused in preparing their tax returns is the process of calculating modified adjusted gross income. This figure differs from adjusted gross income in that some adjustments are added back in to the total. These adjustments can include tuition costs and education deductions, any eligible IRA contributions, losses from rental properties and interest paid on student loans. Self-employed individuals need to add back in half of self-employment taxes paid as well. The MAGI is used to determine whether certain deductions are allowed, including contributions to an individual retirement plan.

For most individuals, adjusted gross income and MAGI are similar; however, both must be calculated to determine total taxable income for any given year. Regardless of whether an individual receives a W-2 or is self-employed, understanding the differences between gross income, adjusted gross income and MAGI is a necessary aspect of filing a correct tax return. The majority of tax preparation software programs perform these calculations behind the scenes, but individuals can more accurately estimate total tax obligations for the year when they have an understanding of these income terms.

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